Global financial crisis and Sri Lanka

Dinesh Iriyagolle Weerakkody

Since early 2007, there had been speculation of a possible recession starting in early or late 2008 in some countries.

US and UK are clearly in trouble. This could be the worst since World War II. In August, Germany and France signalled possible recession which seems a reality now.

Other countries have seen the rate of growth of GDP decrease, generally attributed to reduced liquidity, sector price inflation in food and energy, and the US slowdown. These include eurozone (15-nations), Japan, Australia, China, India and New Zealand.

US will bear the brunt of the economic consequences of the crisis, with the bulk of the impact not being felt until later in the year if immediate measures are not taken when the ripple effect will be felt by other nations.

UK prime minister, last Tuesday ordered taxpayer-backed cash injection to rebuild the balance sheets of Britain’s high street banks, in effect part-nationalising the sector at an estimated cost of between œ35bn-œ50bn.

German output, which accounts for 30 per cent of the 15-nation eurozone economy, fell by 0.5 per cent in the second quarter, the weakest performance in more than five years. However, the economy is still growing at an annual rate of 3.1 per cent. France also posted a shock fall, shrinking by 0.3 per cent, down from a 0.5 per cent rise in the first quarter. This was below analysts’ forecasts for a rise of 0.2 per cent. France is the second biggest economy in the eurozone, accounting for about 16 per cent of output. However, French Economy Minister, rejected talk of recession in August.

Europe’s manufacturing and service industries recorded slow growth. The Swiss government reduced its economic growth forecast for next year.

The $700 billion bailout plan

US Congress has signed into law a $700 billion bailout plan, every one is waiting to see its impact. Up to date over a trillion dollars may have been pumped to revive the financial system with no light at the end of the tunnel.

The bailout package will be financed by the US Treasury through printing money garbed as bonds and bills sold to investors. Another provision approved by Congress will give further tax cuts to businesses. It means that some social programmes for poor Americans will be eliminated because the tax rebates will reduce Government revenues.

The bailout package dollars are being dolled out to Wall Street players who were responsible for the financial mess. Once again, the business lobbies, with deep pockets, have prevailed over the common US citizen.

Some suggest that the huge bailout package can lead to stagflation (rising inflation and unemployment) or a depression. It may be perceived as a disastrous step taken in the direction of same old perilous path that has sucked in the US and the international financial system.

The lower dollar dragged the last hope of world economies into its knees. It has an effect on the real economy which will be felt more in late 2008, with greater intensity in the US, less in other areas. A lot will have to do with the length of the crisis, the longer it lasts, the bigger impact it will have.

The most important financial institutions have enough capital to withstand the shock, and global growth has been solid in 2006 and 2007, though some slowdown could be expected. But this depends on how these economies tackle the issue.

The deceleration in the euro-area economy will continue to be felt, and that leaves the ECB (European Central Bank) with a big problem. The slowdown in economy and increasing inflation is the last thing ECB wants to see.

2008 recession

The United States housing market correction (a consequence of United States housing bubble) and subprime mortgage crisis coupled with high oil prices had significantly contributed to the current recession.

U.S. employers shed 63,000 jobs in February 2008, the most in five years. Former Federal Reserve chairman said in April 6, 2008 that “There is more than a 50 percent chance the United States could go into recession.”

On October 1st, the Bureau of Economic Analysis reported that an additional 156,000 jobs had been lost in September. In April 2008, nine US states were declared to be in a recession.

Although the US Economy grew in the first quarter by 1%, by June 2008 some analysts stated that due to a protracted credit crisis and “rampant inflation in commodities such as oil, food and steel”, the country was nonetheless in a recession.

The evidence has built to the point that it is now beyond a reasonable doubt that the U.S. economy has entered recession.

What is recession?

Recession is a contraction phase of the business cycle. Broadly it is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A sustained recession may become a depression.

Causes of recessions

Currency crises, inflation, national debt, speculation, war can all lead to a recessions.

Effects of recessions

Bankruptcies, banks lend less money, deflation, foreclosures, reduced sales, stock market crash, unemployment are the effects of a recessions.

Predictors of a recession

There are no completely reliable predictors. These are regarded to be possible predictors. It is the opinion of the writer that unlike in the past predicting the present day economic activities of the nations are far more difficult. This is due to the web like tangles, complex connections and links of the economies of world.

Responding to a recession

Strategies for moving an economy out of a recession vary depending on which economic school the policymakers follow. While Keynesian economists may advocate deficit spending by the Government to spark economic growth, supply-side economists may suggest tax cuts to promote business capital investment.

Laissez-faire economists may simply recommend the Government remain “hands off” and not interfere with natural market forces. Populist economists may suggest that benefits for consumers, in the form of subsidies or lower-bracket tax reductions are more effective, and serve a double purpose including relieving the suffering caused by a recession.

Both Government and business have responses to recessions.

Precautions businesses can take

First business owners can gauge customers’ ability to resist recession and redesign customer offerings accordingly. Lean principles can be used, replace unhappy workers with those more motivated, eager and highly competitive. After all on the bright side companies, get better at what they do during bad times.

Central Bank response

Usually, Central Bank’s respond to recessions by easing monetary conditions, e.g. lowering interest rates. In the US, the Federal Reserve has responded to potential slow downs by lowering the target Federal funds rate during recessions and other periods of lower growth.

Cuts in the interest rates are now widely anticipated; thus, cuts are no longer followed by a longer-term rise in stock market indexes.

Sri Lanka

Due to the global nature of the current crisis Sri Lanka will no longer be able to escape unharmed this time around. The impact will depend on the sectors in varying levels. For example, there will be less tourist arrivals from European countries and that will affect the all ready troubled sector.

Rising interest rates and inflationary pressure, US dollar appreciating at the expense of the rupee coupled with a war budget and high public sector expenditure will make things difficult for Sri Lanka.

Few weeks back, Central Bank (CBSL) released more than US$ 22 million into the market in order to defend the rupee. Less and less dollars coming into the markets causes pressure on the rupee thus making it difficult for the (CBSL) to defend the rupee. It is expected the dollar to end at the Rs. 109 levels soon.

As a result the economy may be go into a recession, with cascading effects on the US, EU economy and on the rest of the world as well, because of their dependency on the US economy. The worse is to follow, when foreign funds try to withdraw their funds from Asian markets.

However inward remittances sent in by Sri Lanka’s housemaids in the Middle East and expats may result the country achieving a reasonable outcome in relation to the trade deficit.

Above factors combined will have a detrimental impact on the economic growth if steps are not taken to mitigate the impact.

The way out for Sri Lanka

If the global crisis continues although Sri Lanka will not be able to totally avoid its consequences if certain steps are taken we can avoid a great impact and also will be able to develop the economy.

The continuation US and the Eurozone economic down turn will have a negative impact on the Lanka’s textile and garments exports. Nearly 50 per cent of Sri Lanka’s textile and garments exports went to the US in 2007 while another 45 per cent went to the EU.

The sector is the largest source of foreign exchange earnings, accounting for some 43 percent of the total.

Elimination of terrorism

The 2009 defence budget is estimated at 177.06 billion rupees, 6.4 per cent higher than the estimated 166.45 billion rupees to be spent in 2008. This can be considered as an essential expenditure for future stability of the country.

But this expenditure should not continue beyond 2009. Expected possible gains will not only be lost if the war is prolonged but will have a devastating affect on the economy.

If terrorism is eliminated or controlled at least by the mid to end of 2009 the positive ripple effect will see Sri Lanka to an economic boom.

In fact 177.06 billion rupees hopefully will be available for development and capital expenditure.

Development of rural industries

The industrial sector has been a significant contributor to the Gross Domestic Product (GDP) of the country (27%). But this sector is predominantly confined to the cities of Gampaha and Colombo.

Development of rural industries will see the uplift of that sector and more economic stability in the country despite the global crisis.

If the Government plans to introduce 300 industries under the Gamata Karmantha project goes well, it will cater the growing demand for employment in rural areas.

This project includes 123 programmes with a total investment of Rs.18, 217 million and is expected to generate 26,212 jobs. Of these projects, 27 are in commercial enterprises, 26 pertaining to construction and 23 engaged in preliminary work.

The electrical and electronic sector is another key area that should be earmarked for development.

Developing small and medium business enterprises

Small businesses account for the bulk of businesses in Sri Lanka. Assistance for the development in this sector will create immense benefits to the economy.

This can be achieved by providing equity capital, expertise and technical assistance, corporate governance advice and management of environmental and social risks.

The development and regulating the local financial market and the (high-speed) internet are other key development areas. But what should be at the core of the development strategy is the curbing of corruption and public expenditure.

(The writer is a resident of Australia and is practising as an Australian Solicitor and Barrister. He can be contacted on [email protected])